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Digg's demise: are VCs and founder cash-outs partly to blame?

Digg is dead. Sure, the company won't be disappearing today,
tomorrow or next week, but to anyone who lived through the first .com
bust, the writing is on the wall: the company's redesign woes and
yesterday's 37% staff reduction don't bode well for its future prospects.

For Digg to survive and thrive once again, it's going to have to beat the kind of odds that few companies do.

Perhaps one of the most intriguing aspects of Digg's rise and fall that hasn't been discussed much is founder cash outs. As the Web 2.0 boom got underway and startups like Digg were wooed by VCs competing to invest, the idea that VCs could and should provide liquidity for founders became more commonplace.

The logic was simple: going public wasn't an option for most of these young, fast-growing startups, so it might be good to let founders looking to take some money off of the table do so by selling some of their shares in a big investment round. In many cases, this also made sense from a shareholder structure standpoint, as founders held a large portion of the young company's outstanding stock, and buying founder stock could potentially reduce the amount of dilution required.

One of the founders who was rumored to have taken money off the table in this fashion was Digg's Kevin Rose. While, to the best of my knowledge this was never confirmed, there were numerousreports that Rose had sold millions of dollars worth of stock to Digg investors in multiple financing rounds. Rose's investments as an angel (he has put money into numerous startups, including Twitter and Foursquare) might lend some credence to those claims.

If we assume that Rose took money off the table as being accurate, and couple them with the fact that Rose increased his activities outside of Digg until he took the reigns as Digg's CEO again in April 2010, there's an interesting question: is there a possible relationship between Digg's current woes and the founder's level of investment and involvement?

More broadly, do VCs shoot themselves in the foot when they allow founders to cash out before their startups do? While we have no way of knowing if Rose took money off the table, or how much, we do know that Rose was instrumental in Digg's early success. He had an idea and vision, and he executed on it. For better or worse, he became the face of Digg, and for a time, it appeared he could do no wrong in the eyes of the Digg community. Certainly, Rose has always seemed to be more in tune with members of the Digg community than anyone else who has served at the company's helm.

One might very well argue that as Rose disengaged from Digg and became involved in other ventures, Digg lost an important part of its secret sauce: the influence of its founder. Whether or not Rose's disengagement was due to the fact that he was financially comfortable, it's hard not to think that founders like Rose might lose a bit of their fire or become distracted by other entrepreneurial callings once they have some cash in their pockets.

With Digg as a possible real-world example of this, VCs might want to look at this more closely when the third internet startup boom hits. The landscape for venture capital is as complicated and challenging as it has ever been, and while there may be good reasons to provide for some level of founder liquidity, it's unclear whether companies will be any better off for the practice, at least as it was implemented during the heady days of Web 2.0.

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Anonymous

Founders cashing out prior to their creations seems like a poor confidence builder at best, and seems borderline from an ethical standpoint. It smacks of a dangerously cozy relationship between VCs and their 'favorite founders', the chosen few who sit around the VC dinner table and can raise capital for their latest half-baked ideas.
To me, the real reason that Digg failed is that it made the crushing mistake of going from innovator to wannabe with its fourth iteration. The moment you do that, you lose the respect of your loyal fan base, and fail to generate a new one from a larger group that doesn't need you. Of course, in Silicon Valley, as in Hollywood, failure is often good for one's bottom line. Mr Rose doesn't have to worry. It's unlikely his friends will abandon what they know for the more challenging task of choosing a meritocratic winner from among those they don't.

over 7 years ago

Michelle

Anonymous,

Your comment about Digg and VC relationships with "famous founders" and the idea that part of Digg's demise was due to going from innovator to wannabe. Loyal following is easily lost, especially if they see that there has (allegedly) been founder payout and I also agree whole heartedly that it runs borderline of ethical wrong doing. Loyal followings will turn into haters to any company if such founder cash outs are evident. -Michelle

Interesting article. I think Social Bookmarking always had a limited appeal and the surge in use of Twitter has made it virtually redundant.

over 7 years ago

Timothy

Oh come on. A founder cannot cashout? Are you so full of your own branding talk that you've lost touch with the world. Digg's existence isn't based on its founder, it's community driven. Whereas the comments may hold value when discussing a single author blog, they hardly hold value in reference to an app or where the value is not driven directly by the founder.

Users, and especially technical ones, understand a founder will sell shares eventually, that doesn't mean he's given up, it's how business works.

@Timothy - I think it's just a question of when cashouts take place, and whether founders subsequently get sidetracked or moved on, and the effect that has on the ability to execute to the original vision (not always the best vision: there are tons of examples of firms that have done amazingly well after VC investment. Founders are not always the best CEOs once a company achieves a certain scale...).

In Digg's case questions are being asked, and much of the scrutiny has come on the back of the failed v4 of Digg. Yesterday revelations about the possible gaming of Digg by Digg is a far greater risk to the company's reputation than the firing of a bunch of staff, or the poor response to v4.

Digg is still a big website and it's not game over just yet, but I do fear a Yahoo-esque slide into obscurity unless it figures out how to get the best out of its community.

Digg was a victim to its own success. By empowering a small group of users to determine the popularity of articles online, Digg forfeited control of its destiny to those users. Digg founders 'cashing out' didn't kill dig. The people that killed it were those select few Diggers that continue to hijack and disrupt every improvement with the site.

If a new company had popped up with the same design as the 'new Digg', we'd all be reading about how great it was as a bookmarking engine. Instead, Digg is caving into the very people that are killing it. No one wants to belong to a network where their voice is ignored... or silenced.

over 7 years ago

Investor who knows

Dipshits, Digg did not succeed. Stop with the victim of its own "success" horseshit. Success means succeeding.

over 7 years ago

Anonymous

Investor who knows knows. The measure of success in the boosterist world of internet 'success' is not the same as in the boring old nuts and bolts world that the rest of us inhabit.

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